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Securities companies in Japan

Jun

30

1994

0

By David Luhman

Securities companies in Japan

Japanese securities houses are another group of protected, concentrated financial players like the insurance companies. Japan's securities houses have been protected from competition with banks, foreign securities houses and themselves.

Japanese securities firms have gained much from Article 65 of the Securities and Exchange Law. This US-imposed version of the Glass-Steagall Act ensured for many years that the powerful, keiretsu-aligned banks could not underwrite equities or bonds.

Securities companies also were protected from foreign competition. Foreign investment banks like Morgan Stanley, Merrill Lynch, Salomon Brothers, and about twenty other firms now have seats on the Tokyo stock exchange, but foreign firms were kept out of the market for many years. For example Merrill Lynch first set up an office in 1961, but it wasn't allowed to join the Tokyo Stock Exchange until 1986.

Japanese securities firms also have protected themselves through fixed commissions and a lack of competition in underwriting.

Although brokerage commissions were deregulated in America in 1975, Tokyo commissions are still fixed. Commissions may be deregulated soon, but they are still much higher in Tokyo than in New York. For example, a $200,000 trade in New York may cost 20 basis points, but a similar trade in Tokyo would cost 70 basis points.

Profiteering is nearly as bad when it comes to underwriting. Although underwriting fees are not fixed, they might as well be because stock underwriting is dominated by four firms - Nomura, Nikko, Daiwa and Yamaichi - collectively known as the Big Four.

The Big Four account for about 40 percent of the turnover on the Tokyo Stock Exchange. When it comes to equity underwriting, the Big Four control over 70 percent of the market.

This kind of oligopoly leads to higher prices, and in Tokyo the average underwriting fee for a seasoned stock issue is 6 percent. In America it's more like 3 to 4 percent.

However this easy and uncompetitive environment for Japanese securities firms may ultimately backfire on them because they are losing out to more nimble Western firms.

Because of the lack of income from fixed commissions, American investment banks have grown accustomed to dealing on their own account to make money. Much of this income arises from risk-free arbitrage trading with derivative securities.

At one time Japanese securities firms also traded on their own accounts, but they tried to make money by taking equity positions rather than arranging risk-free deals. Many Japanese securities firms burned themselves badly in the 1964 bear market and have avoided trading on their own accounts ever since. For example Nomura has only three percent of its assets in stocks.

However Japanese securities firms may have to sharpen their trading skills in the future as brokerage commissions become unfixed and competition from new securities subsidiaries of banks increases.

Underneath the Big Four lie the so-called second and third tier of securities firms. In all there are about 220 securities houses in Japan and about 125 of these have seats on the Tokyo Stock Exchange.

Because these smaller second and third tier firms are essentially shut out of the underwriting business by the Big Four, their incomes are highly dependent on commission income. This kind of income dries up in a bear market, so these smaller firms rely on relationships with large Japanese banks and insurers to keep a steady stream of business coming their way.